• This is the most faithful replication of a true-sale structure and so is our chosen starting point. It is also (subject to a significant number of points of detail) generally capable of achieving capital relief across core jurisdictions.
• The originator enters into a financial guarantee, credit derivative or similar unfunded risk transfer instrument with an orphan a special purpose vehicle (SPV). This instrument sets out the reference portfolio of loans and establishes the tranching.
• Under Basel rules, an SPV is only eligible to provide capital relief if its obligations under the credit protection instrument are fully collateralized. To provide the collateral, the SPV issues a note to the investor, in an initial principal amount equal to the size of the investor’s tranche. The note proceeds are held by a deposit bank.
• If an asset defaults and a loss is allocated to the investor’s tranche, (i) the SPV pays an amount equal to the amount so allocated to the originator, and (ii) the note’s principal amount (and so the amount ultimately repaid to investors) writes down by the same amount. 
• If the originator and deposit bank are not one and the same, the originator will need to hold capital against the risk that the deposit bank will not perform (or, if the cash proceeds are invested in securities, the risk that their issuer(s) will default; hence, a popular practice is to invest the note proceeds in treasuries, which, like cash held directly by the originator where it is the deposit bank, are favorably treated). Note that, if the originator and deposit bank are one and the same, this introduces originator credit risk for the investor for the return of the note principal.

This replicates the above structure, but this time the originator itself issues the note rather than using an SPV intermediary. The portfolio constitution, tranching and loss allocation all work in the same way as above.

This time, the collateral is provided directly to the originator upfront. The note writes down in the same way as above, and the originator ultimately repays to the investor its initial investment minus losses allocated to the protected tranche.

It can be cheaper and simpler to avoid using an SPV (which can introduce tax complications and trigger the application of other regulatory regimes), as well as being more capital efficient for the issuer. However, this introduces originator credit risk for the investor, and has not historically been as reliable a method of capital relief in all jurisdictions. Also, a direct CLN is a securities issuance by the originator and compliance with securities laws (including disclosure requirements) in applicable jurisdictions will need to be considered.

Unlike the previous two examples, this structure does not employ a securities issuance to collateralize the credit protection obligations of the investor. As above, the portfolio constitution, tranching and loss allocation all work in the same way as the previous structure.

The originator and the investor enter into a bilateral credit protection contract (which will look potentially very similar to the instrument between the originator and the SPV in the first structure). This instrument may be drafted as a guarantee or credit derivative (derivatives being preferred in the US in order to fit within the local regulatory rules).

The investor then pledges collateral in favor of the originator to a value at least equal to its maximum possible payment obligations under the protection, and is only paid to the originator (or available by way of enforcing the pledge) as and when losses hit the protected tranche. Alternatively, the collateral may be transferred outright and returned to the investor minus losses at maturity.

A pledge structure can help where the investor is particularly allergic to credit risk on the originator. However, since the originator is relying on pledges of collateral held by a third-party bank, this can result in a less efficient capital outcome. 

• Each of the above structures is funded; the originator is fundamentally looking to some particular assets, either pledged in its favor or transferred to it upfront, in order to secure the investor’s credit protection obligations.
• However, the Basel rules also permit certain entities to provide uncollateralized protection, i.e. the originator can claim capital relief based on the protection provider’s promise to pay. The entities who can provide this are restricted, very broadly only state bodies, multilateral development banks, prudentially rated financial institutions and highly-rated (or investment grade) corporates (typically insurers). Even then, local regimes often restrict the eligibility of this form of credit protection even further (for example, the US regime and the EU regime for simple, transparent and standardized on-balance sheet securitizations).
• If this format is available, then the originator will (broadly) be effecting risk weight substitution in relation to the placed tranche. All else being equal, an unfunded deal can therefore be less efficient from a capital perspective (unless the guarantor is of a kind that benefits from deemed 0% risk, as is often the case for state bodies and multilateral development banks), though it may be more efficient overall once pricing and other factors are taken into account.