Structured finance is a terminology used to illustrate a sector of finance management analysis which seeks to solve risk management through transference via complex corporate and legal channels. The securitization of different financial resources such as credit card receivables, auto loans, and mortgages among others, has contributed to the aperture of opportunities to new resources of financial accommodations for the company’s market.
Structured finance may also refer to formations created by financial institutions such as banks, to vouch for collateral investments and physical developments in real estate. This structure aims to differentiate debt and equity elements of real estate. The loan compositions of this system are the actual current valuation of the leased cash influx and outflux. The equity composition of this system is the valuation of the real estate at the termination of the lease period. This process, however, does not neglect the significance of tax exemptions and benefits[1].
Securitization is one important factor to this concept of structured financing. It is employed to generate a collection of assets which are utilized in creating an advent for the production of other financial apparati. Tranching is another significant concept in this matter. It is considered as the system which defines the classification and fragmentation of various investment classes which are securitized in the creation of the structure of the financial movement."A key goal of the tranching process is to create at least one class of securities whose rating is higher than the average rating of the underlying collateral pool or to create rated securities from a pool of unrated assets. This is accomplished through the use of credit support (enhancement), such as prioritization of payments to the different tranches.”[2]
Credit enhancement is another factor in this system. It is the main component in the recipe for attaining a security asset when a company attempting the acquisition has a lower rating than the company producing the security asset. Subordinate bonds can be fabricated and doled out in order for credit enhancement to be generated. Credit ratings are also significant to assess in the structuring of financial activities of a specific company.
This issue first arose at the third quarter of the year 2002 at the onset of the problems which were experienced by Enron and other financial institutions who have utilized the system of structured financial management. It has stirred law-makers and the judiciary alike to challenge the effectiveness of such complex financial activities. Because of this, suggestions on getting leverage on the concentration of special-purpose entities (SPEs) utilized in structured finance operations[3]. The actual quandary may be pointed to lie in the existing accounting laws that neglect to take into consideration a number of the contracts wherein SPEs are commonly engaged in. One example of these is executor contracts, these are contracts in which the agreeing sides have yet to consolidate their actions and finalize the merger.
In conclusion, these problems may be seen to lie on the neglect of the performing financial institutions to consider the many factors which affect their decisions and actions and the corresponding consequences of the decisions and actions they make. Structured financial systems may have strong points in its compositions, but provide many loop holes as well which requires attention which, if ignored, may lead to the fall-down of the very institutions themselves.
References
Bank for International Settlements 2005, The role of ratings in structured finance: issues and implications, Bank for International Settlements, United States of America
Evans, K 2001, ‘Structured finance in the South African real estate marjet: who are the winners – borrowers or lender?’, PhD Thesis, University of Cape Town, Cape Town
Ryan, S 2002, ‘How should accounting cope with structured finance?’, in Financial instruments and institutionsL accounting and disclosure, John Wiley & Sons, United States of America
[1] Evans, K 2001, ‘Structured finance in the South African real estate marjet: who are the winners – borrowers or lender?’, PhD Thesis, University of Cape Town, Cape Town
[2] Bank for International Settlements 2005, The role of ratings in structured finance: issues and implications, Bank for International Settlements, United States of America
[3]Ryan, S 2002, ‘How should accounting cope with structured finance?’, in Financial instruments and institutionsL accounting and disclosure, John Wiley & Sons, United States of America
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