Structured products & Securitization moving online


By Efi Pylarinou

“Structured finance isn’t dinner table conversation for most people — and the terminology, market dynamics and ecosystem can be imposing”                                 Hyung Kim, Co-Founder of Ldger

Structured products are one of the tools used in financial markets to re-allocate risk and create customized payoffs that are suitable for each investor class. Pensions funds and hedge funds, are naturally positioned in different areas of the risk return space.

A structured product is a derivative product. You can think of it as a “machine” that transforms a typically large pool of cash flows into a few different categories of some newly created instruments. One simple example, is pooling credit card cash flows and then creating 3 new buckets in which you allocate the pool of cash flows. The “top” bucket is higher credit and gets paid first (lower yield), the second gets paid once the first one is paid off (of course higher yield), and the third one are the residual cash flows. There are so many variations of these structures that they cant even fit in one fat book.

There are two main areas for Fintechs to offer value in the structured market area. One relates to more transparency in all the stages of the product cycle and the other to improving the structuring process. Structured products are highly customized with a wide range of underlying assets and lots of entities involved. Inefficiencies exist in:

  • Discovering the structure that is “optimal” or suitable
    • For example, I have a view on oil, what is the best structure to express this view
    • Or, I want to hedge an exposure, what is the best structure to attaint this
  • Issuing a structure
    • For the asset holders (owning a pool of cash flows) who want to replenish capital
    • For an asset manager who wants to own a portion of a homogenous pool of cash flows
    • Too many entities involved (issuer, primary & backup servicer, paying agent, trustee, custodian, rating agency etc)
  • Pricing and Liquidity
    • A transparent structure with an improved mark to market and risk valuation mechanism of the underlying poll of cash flows
    • A reasonable bid offer spread of the structure

There are two Fintechs in the broad structured product space. Contineo who is focused on equity linked structures in the Asian market, which has traditionally been a large user of structured products due to local regulations. It is backed by industry lead names, like JP Morgan, Barclays, Goldman Sachs. Contineo aims to deliver to the players (B2B) in this market, Buy side and Sell side, a win-win tool. It is like the Algomi of structured products. The former aims to solve the fixed income conundrum and Contineo, the structured products conundrum. Quotip is a Swiss Fintech startup, tackling the same problem for the Western markets. Quotip was recently, selected for the Accenture Fintech Innovation Lab in London and is not in the dis-intermediation business but rather addressing a complex mutli-issuer and mutli-asset market that needs to be revived. It offers a platform for structured product idea generation, request for quote, and audit/life-cycle management, as explained in the Forbes article “More collaboration than disruption in Accenture’s London Fintech Lab”.

Two Fintechs also in the structured product space but strictly in securitizing assets from the new lending marketplaces, are PeerIQ and Ldger. This niche focus, adds more complexity because the underlying cash flows are sourced from unregulated entities and through a direct match making process of borrowers and lenders. The market is not yet comfortable with current risk assessments because there isn’t enough history to extrapolate default rates.

PeerIQ is positioned as a P2P credit risk analytics platform and loan data provider in the space. They are developing benchmark analytics and tools like the Marketplace Lending Securitization Tracker, that are essential to institutional investors wanting to get involved in the space. Their mission is to be an enabler for improved secondary market conditions in the origination space and to offer more transparency and understanding that will lead to an increase in the volume of securitized deals.

The backers of this startup are from the incumbents (e.g. John Mack, Vikram Pandit, and Arthur Levitt, to name a few as mentioned in “Bold-Faced Wall Street Names Back Loan Data Startup PeerIQ).

Ldger is also a startup founded by lawyers that aims to be the Lego land for securitized deals with building blocks only from lending marketplaces. “Build your own securitization” as JJ HORNBLASS dubs Ldger in “Why Marketplace Lending Is Set to Boom”. Imagine a platform that one can build customized tranches from pools of cash flows originating from lending marketplaces. The aim is not to facilitate lower denomination deals to happen. On the contrary, the aim is to enable larger deals to happen. Ldger wants to be there as the deal flow, increases which is one of the prerequisites for a decent securitization deal (i.e. to ensure that the pool can be scalable and with a long life). Ldger wants to lower the cost of the process, make it faster and with wider distribution. The deals that will be custom tailored on their platform will be transparent and audible. Ldger will integrate cash flow servicing and reporting. Ldger is inviting origination platforms to integrate their APIs to the Ldger platform.

Like a child’s Lego game, securitization involves many different players and can create various outcomes even though using always the same blocks. Regulation is challenging for structured products and even more for structured finance. All Fintechs involved in this space are helping regulators and buy/sell side in creating a safer, larger, more liquid and more mature market.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech. Efi Pylarinou is a Digital Wealth Management thought leader.

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