A substitution period is a period of time during which the issuer of a securitisation can replace the underlying assets in the securitisation with other assets. This is typically done to maintain the credit quality of the securitisation or to take advantage of favorable market conditions.
The substitution period is typically set out in the securitisation documents. It is important to note that the substitution period does not apply to all types of securitisations. For example, it is not typically used in securitisations of mortgages, as the underlying mortgages are typically considered to be relatively stable assets.
A substitution period is sometimes referred to as a "replacement period" or a "trading period".
Here are some of the applications of substitution periods in securitisation:
- To maintain credit quality: If the credit quality of the underlying assets in a securitisation deteriorates, the issuer may be able to replace them with other assets that have a higher credit quality. This can help to maintain the credit quality of the securitisation and to protect investors from losses.
- To take advantage of favorable market conditions: If market conditions are favorable, the issuer of a securitisation may be able to replace the underlying assets with other assets that have a higher yield. This can help to increase the returns for investors.
- To manage liquidity: If the issuer of a securitisation needs to raise cash, it may be able to replace the underlying assets with other assets that are more liquid. This can help the issuer to raise cash more easily.
It is important to note that the substitution period is a complex legal concept and there are a number of factors that need to be considered when using it. Investors should carefully review the securitisation documents to understand how the substitution period will work in practice.