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American Secul'itization Foi'Um1 Discussion Points 

Swap and Margin Rules 

July 6, 2011 

General Discussion 

• The proposed common rules, among other things, generally require covered swap 

entities to collect initial and variation margin from their counterparties for noncleared swaps, depending upon the type of counterparty, and limit the type of eligible 

collateral for margin to immediately available cash funds, treasuries and for initial 

margin only, senior debt obligations of certain government sponsored entities 

(hereinafter, "Liquid Margin"). 

• We believe that the application of the proposed common rules to structured finance 

swaps is not required by the Dodd-Frank Act, will not serve the policy embedded in 

the Dodd-Frank Act to reduce systemic risk and will lead to less liquidity in the 

structured finance market. Structured Finance Swaps were not a comer of the swap 

market requiring legislation following the 2008 crisis and have more than adequate 

built-in protections against systemic risk. 

Background on Structured Finance Use of Swaps 

• Although there is no universal definition of "structured finance", the Bank of 

International Settlements definition is instructive, which is as follows: Structured 

finance instruments can be defined through three key characteristics: (i) pooling of 

assets (either cash-based or synthetically created); (ii) tranching of liabilities that are 

backed by the asset pool; and (iii) de-linking of the credit risk of the collateral pool 

from the credit risk of the originator, usually through the use of a finite lived, 

standalone special purpose vehicle ("SPV'). 

• Interest rate and currency derivatives are among the most commonly used swaps for 

structured finance participants. Typically, structured finance participants use swaps 

to hedge floating interest rate liabilities. Swaps are an integral part of the structured 

finance and securitization structures; in particular, with respect to mortgage-backed 

1 The American Securitization Forum ("ASF") is a broad-based professional forum through which participants in the 

U.S. securitization market advocate their common interests on important legal, regulatory and market practice 

issues. ASF members include over 330 firms, including issuers, investors, servicers, financial intermediaries, rating 

agencies, financial guarantors, legal and accounting firms, and other professional organizations involved in 

securitization transactions. The ASF also provides information, education and training on a range of securitization 

market issues and topics through industry conferences, seminars and similar initiatives. For more information about 

ASF, its members and activities, please go to www.americansecuritization.com. 

One World Financial Center, 30th Floor • New York, NY 10281 -0006 • 212.412.71 00 

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www.americansecuritization.com 
securitizations, interest rate swaps enable structured finance SPVs to hedge liabilities 

relating to the underlying asset of 30-year fixed-rate mortgage loans. 

• Structured finance swaps are not used for speculative purposes and structured finance 

participants typically use few structured finance swaps per structured financing. 

• Other important features of structured finance swaps include that they do not have a 

predetermined notional amount and other than in a default situation, they are usually 

senior in the waterfall to the other obligations of the structured finance SPY. 

Structured Finance Swaps are often overcollateralized with the collateral of the 

securitization (the receivables). Attachment 1 shows an example of an automobile 

loan securitization. The example shows that at t-1 under scenario 2, which assumes a 

1.5x maximum interest rate movement, without liquid margining, the structure would 

have 3.9 times as many assets as (in terms of receivables) it would need to cover the 

required collateral on the swap, which level of collateralization is by far higher than 

the default initial and variation margin levels contained in the releases proposing the 

margin rules. 

Implications for Applying the Proposed Rule to Structured Finance 

• As special purpose vehicles, the structured finance SPVs would not be able to comply 

with these requirements standing alone. Structured finance SPVs do not typically 

have access to Liquid Margin as would operating vehicles. 

• Applying Liquid Margin requirements to structured finance SPVs would present the 

sponsoring group with a choice to either retain more of the economic risk of the 

structured finance issuances or forego such issuances. 

• The regulation of retention of economic risk by sponsoring groups is the subject of 

other provisions of Dodd-Frank, notably Section 941. There is no legislative intent 

demonstrating that the Title VII derivatives provisions were intended to be applied on 

top of the risk retention requirements contained elsewhere in Dodd-Frank. 

• The application of a Liquid Margin requirement may render many structured 

financings uneconomic as the structured finance SPY would be required to post cash 

and liquid securities which it does not have. 

• Requiring the posting of liquid collateral would affect the cash flow analysis for a 

structured financing and ultimately reduce the amount of loans or other financing for 

the assets underlying the structured financing. This would have an effect on the real 

economy-including auto loans and credit card loans- at a time when the economy is 

still trying to recover. 

• Attachment 1 reflects the foregoing point. Attachment 1 assumes an interest rate 

swap related to an automobile securitization offering, that the size of the automobile 

securitization offering and related notional amount of the swap is $100, the duration 

of the offering is 4.25 years, the required initial margin is 2% of the notional amount 

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(which is consistent with the standardized minimum initial margin requirements on 

Appendix A of the Release), the offering and swap notional amortize according to 

historical prepayment levels and variation margin is posted dollar for dollar with no 

threshold. Attachment 1 shows the effect of posting Liquid Margin under two 

scenanos. 

o In Scenario #1, we assume that interest rates have moved during the relevant 

time period by 95% of the historical movement in interest rates over such a 

period since January 1984. In Scenario #2, we assume that interest rates have 

moved during the relevant time period 150% of the historical movement in 

interest rates over such a period. In order to create a margin reserve under 

both scenarios there will be less cash flow initially to make loans under either 

scenario. In Scenario #1, there will be $9.83 less available at inception to 

make loans, while in Scenario #2, there will be $21.13 less available at 

inception to make loans. 

• The cost of this reduced liquidity could conceivably be justified if it was achieved 

along with the benefit of a reduction in risk to the structured finance SPV' s 

counterparty and a reduction overall in systemic risk. However, as described above, 

under current market practice, structured finance swaps are typically 

overcollateralized with the collateral-receivables that are the subject of the structured 

financing. 

P•·oposed Solutions 

• While there may be many ways of avoiding the result and the foregoing consequences 

of applying the Liquid Margin requirements to structured finance swaps, we believe 

that this could be done by either amending the proposed common rules to (i) permit, 

as they do with end users, thresholds that do not mandate margin for structured 

finance SPVs or alternatively, (ii) not require structured finance SPVs to use Liquid 

Margin, but instead to rely upon the senior cashflow priority of these swaps in the 

structured finance waterfall, consistent with current market practice. 

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Attachment 1-Example of a Liquid Mar·gin Requirement on a Structured Finance Swap 

Budgeting for collateral reserve allocated at time zero 

95th percentile histOJical interest rate movement 

t=1 t=2 t=3 t=4 

Size $100.00 $100.00 $100.00 $100.00 

Duration at inception 4.25 4.25 4.25 4.25 

Required upfront 2% 2% 2% 2% 

Required upfront $ $2.00 $2.00 $2.00 $2.00 

95% interest rate movement 2.87% 4.65% 5.37% 5.25% 

Remaining duration at that time 3.25 2.25 1.25 0.25 

Remaining balance at that time $81.94 $62.97 $43 .01 $22.04 

Swap 95% mtm movement $7.63 $6.59 $2.89 $0.29 

Collateral haircut 98% 98% 98% 98% 

Totalr·equired collateral $9.83 $8.77 $4.99 $2.34 

Effective existing overcollateralization 8.3x 7.2x 8.6x 9.4x 

Funding cost (bps) 50 50 50 50 

Collateral earnings (bps) 0 0 0 0 

Negative carry (bps) -50 -50 -50 -50 

Total net running collateral cost$ -$0.05 -$0.04 -$0.02 -$0.01 

Total net running collateral cost 

(bps) -4.92 -4.38 -2.49 -1.17 

Budgeting for collateral reserve allocated at time zero 

1.5x maximum historical interest rate movement 

t=1 t=2 t=3 t=4 

Size $100.00 $100.00 $100.00 $100.00 

Duration at inception 4.25 4.25 4.25 4.25 

Required upfront 2% 2% 2% 2% 

Required upfront $ $2.00 $2.00 $2.00 $2.00 

Max x 1. 5 interest rate movement 7.02% 7.94% 9.09% 10.69% 

Remaining duration at that time 3.25 2.25 1.25 0.25 

Remaining balance at that time $81.94 $62.97 $43.01 $22.04 

Swap max x 1.5 mtm movement $18.71 $11.24 $4.89 $0.59 

Collateral haircut 98% 98% 98% 98% 

Total required collater·al $21.13 $13.51 $7.03 $2.64 

Effective existing overcollateralization 3.9x 4.7x 6.1x 8.3x 

Funding cost (bps) 50 50 50 50 

Collateral earnings (bps) 0 0 0 0 

Negative carry (bps) -50 -50 -50 -50 

Total net running collateral cost $ -$0.11 -$0.07 -$0.04 -$0.01 

Total net running collateral cost 

(bps) -10.57 -6.76 -3.52 -1.32 

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