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Structured finance is a broad term used to describe a sector of finance that was created to help transfer risk using complex legal and corporate entities.

Unfortunately structured finance, while widely used, is rarely defined and does not have a consistent definition. But among those who practice and study structured finance, a fairly effective definition emerges.

Contents 1 Definition 2 Important aspects of structured finance 2.1 Securitization 2.2 A securitization transaction 2.3 Tranching 2.4 Credit Derivatives 3 Credit Enhancement 4 The Use of Ratings in Structured Finance 5 References 6 See also

According to Andreas A. Jobst, "Structured finance encompasses all advanced private and public financial arrangements that serve to efficiently refinance and hedge any profitable economic activity beyond the scope of conventional forms of on-balance sheet securities (debt, bonds, equity) in the effort to lower cost of capital and to mitigate agency costs of market impediments on liquidity. In particular, most structured investments (i) combine traditional asset classes with contingent claims, such as risk transfer derivatives and/or derivative claims on commodities, currencies or receivables from other reference assets, or (ii) replicate traditional asset classes through synthetication." ^[1]

The Committee on the Global Financial System defined structured finance in their January 2005 report, "The role of ratings in structured finance: issues and implications", as "Structured finance instruments can be defined through three key characteristics: (1) pooling of assets (either cash-based or synthetically created); (2) tranching of liabilities that are backed by the asset pool (this property differentiates structured finance from traditional “pass-through” securitisations); (3) de-linking of the credit risk of the collateral asset pool from the credit risk of the originator, usually through use of a finite-lived, standalone special purpose vehicle (SPV)."^[2]

Essentially, structured finance is made up of Pools of either, traditional consumer based asset-backed securities like credit cards, auto loans or Pools of corporate debt obligations such as bonds and CDO's. These pools are often created using Securitization.

Structured Finance "...involves the pooling of assets and the subsequent sale to investors of claims on the cash flows backed by these pools. Typically, several classes (or “tranches”) of securities are issued, each with distinct risk-return profiles. In addition, the underlying collateral asset pool is usually legally separated from the balance sheet of the transaction’s originator. Assets in the collateral pool can range from cash instruments (eg residential mortgages, credit card receivables, loans and bonds) to synthetic exposures, such as credit default swaps (CDSs). Depending on the nature of these assets, pools may contain large numbers of relatively homogeneous individual holdings (eg several tens of thousands of consumer loans) or may be made up of rather heterogeneous exposures to a limited number of obligors (ie some 50-150 in the case of CDOs)"^[2]

For an example of a structured finance deal please see Securitization.

Main article: securitization

Securitization provides the method participants of structured finance utilize to create the pools of assets that are used in the creation of the end product financial instruments.

Because securitization is such an important tool used in structured finance, it is important to see how a securitization transaction would actually occur.

Main article: Securitization transaction

Main article: Tranche

Tranching is an imporant concept in structured finance because it is the system used to create different investment classes for the securities that are created in the structured finance world. Tranching allows the cash flow from the underlying asset to be diverted to the various investor groups. The Committee on the Global Financial System explained tranching succinctly: "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 prioritisation of payments to the different tranches."^[2]

Credit Derivatives are another area of Structured Finance, "[they] are financial instruments that isolate and transfer credit risk" "In their basic concept, credit derivatives sever the link between the loan origination and associated credit risk, but leave the original borrower-creditor relationship intact."^[1]

Main article: Credit derivative

Credit Enhancement is key in creating a security that has a higher rating than the issuing company.

Main article: Credit enhancement

Ratings play an important role in structured finance.

Main article: Credit rating agency

1. ^ ^{a b} Jobst, A "What Is Structured Finance?" September 2005
2. ^ ^{a b c} The Committee on the Global Financial System defined Structured Finance, "The role of ratings in structured finance: issues and implications", January 2005

• Structured finance
• Collateralized Bond Obligation
• Collateralized Debt obligation
• Mortgage-backed security
• Asset-backed security
• Securitization transaction
• Credit enhancement
• Pooled investment
• Tranche
• Privatization
• Thomson Financial League Tables