Risk retention is a requirement that the originator or sponsor of a securitisation retain a certain percentage of the credit risk of the underlying assets. The purpose of risk retention is to align the interests of the originator or sponsor with those of the investors.
The amount of risk that must be retained by the originator or sponsor is typically 5%.
Risk retention can be achieved by retaining the underlying assets, retaining a portion of the cash flows from the underlying assets, or by providing credit enhancement to the securitisation.
Risk retention is an important part of securitisation, as it helps to protect investors from losses.
Here are some applications of risk retention in securitisation:
- Mortgage-backed securities: In a mortgage-backed security, the originator or sponsor is typically required to retain 5% of the underlying mortgages. This means that the originator or sponsor will share in the losses if the mortgages default.
- Collateralized debt obligations: In a collateralized debt obligation, the originator or sponsor is typically required to retain 5% of the underlying debt securities. This means that the originator or sponsor will share in the losses if the debt securities default.
Risk retention is a complex legal process, and it is important to ensure that the risk retention is properly implemented.