Basel II’s Proposed Enhancements: Focus on concentration risk
by Martin Hansen of Fitch Ratings, Krishnan Ramadurai of Fitch Ratings, Roger Merritt of Fitch Ratings, Ian Linnell of Fitch Ratings, John Olert of Fitch Ratings, and Stuart Jennings of Fitch Ratings
April 16, 2009
Executive Summary: Early in 2009, the Basel Committee proposed a number of enhancements to the Basel II capital framework. Amongst the proposed changes to Pillar 1 is an increase in the regulatory capital charges for "re-securitizations" (e.g. SF CDOs, or collateralized debt obligations backed by an underlying pool of asset-backed or structured finance securities) to capture potential concentration risk and tranche thinness of the underlying structured finance collateral, which in this view magnifies systematic risk and ratings volatility of the re-securitization or SF CDO exposure.
Fitch recognizes the unique risk attributes of re-securitizations and recently developed revised SF CDO ratings criteria that focused on many of the same issues that appear to concern regulators, such as concentration risk and tranche size. For example, Fitch’s methodology uniquely recognizes vintage concentration and the risks posed by common underwriting attributes affecting a pool of securitized assets. The proposed Basel II increase in capital charges on SF CDOs coupled with Fitch’s revised ratings criteria could result in the Basel II charges across the SF CDO structure far exceeding the Basel II charges on the underlying structured finance assets in the collateral pool -- contrary to the principle that the same fundamental risk exposure should face broadly similar Basel II capital requirements.
