A securitized instrument, as compared to a direct claim on the issuer, will generally have the following features:
The very purpose of securitization is to ensure marketability to financial claims. Hence, the instrument is structured in such a way as to be marketable. This is one of the most important features of a securitized instrument, and the others that follow are mostly imported only to ensure this feature. Marketability involves two concepts: (1) the legal and systematic possibility of marketing the instrument; (2) the existence of a market for the instrument.
As far as the legal possibility of marketing the instrument is concerned, traditional mercantile law took a contemporaneous view of marketable documents. In most jurisdictions in the world, laws dealing with marketable instruments (also referred to as negotiable instruments) were mostly limited in relation to what was then in circulation.
The very purpose of securitization will be defeated if the instrument is loaded on to a few professional investors without any possibility of having a liquid market. Liquidity is afforded to a securitized instruments either by introducing it in to an organized market (such as securities exchanges) or by one or more agencies acting as, market makers i.e. agreeing to buy and sell the instrument at either pre-determined or market-determined prices.
To be market acceptable a securitized product should be of saleable quality. This concept, in case of physical goods, is something which is acceptable to merchants in normal trade. When applied to financial products, it would mean that the financial commitments embodied in the instruments are secured to the investors’ satisfaction. To the investors satisfaction is a relative term and therefore, the originator of the securitized instrument secures the instrument based on the needs of the investors.
For widely distributed securitized instruments, evaluation of the quality, and its certification by an independent expert, viz., rating is common. The rating is for the benefit of the lay investor, who otherwise not expected to be in a position to appraise the degree of risk involved.
In case of securitization of receivables, the concept of quality undergoes a drastic change, making rating a universal requirement for securitization. As already discussed, securitization is a case where a claim on the debtors of the originator is being bought by the investors. Hence, the quality of the debtors’ claim assumes significance, which at times enables investors to reply purely on the credit rating of debtors (or a portfolio of debtors) and so, make the instrument totally independent of the originators’ own rating.
The basic purpose of securitization is to distribute the product. The extent of distribution which the originator would like to achieve is based on a comparative analysis of the costs and the benefits that can be achieved Wider distribution leads to a cost benefit, in that the issuer is able to market the product with lower return, and hence, lower financial cost to him. But a wide investor base involves the high cost of distribution and servicing.
In practice, securitization issues are still difficult for retail investors to understand. Hence, most securitizations are privately placed with professional investors. However, it is likely that in the future, retail investors could be attracted into buying securitized products.
Securitization is the process of commoditization, where the basic idea is to take the outcome of this process into the capital market. Thus, the result of every securitization process, whatever might be the area to which it is applied, is to create certain instruments which can be placed in the market.