Editor's Letter

We begin with a section on subprime mortgage-backed securities and the financial crisis, as we have for the past six quarterly issues. Joshua Rosner points to the shortcomings he sees in the Nationally Recognized Statistical Rating Organizations’ (NRSROs’) approach toward structured finance securities and recommends a series of changes he believes would improve the process, including requiring charter constrained investors to own only exchange traded structured securities, requiring the NRSROs to apply updated models in a timely manner, and requiring frequent re-rating relative to the original deal assumptions when the securities were issued. Michael Bykhovsky points to the lack of transparency in the over-the-counter market for structured finance securities and problems he sees with the federal government bailout efforts so far, and recommends a number of improvements in the system, including public disclosure of bond transaction prices and collateralized mortgage obligation collateral information, other reporting and capital requirements that realistically reflect the risks financial institutions are taking, and requirements that mortgage servicers take actions that maximize the economic value of mortgages to lenders.

Then Tony Sepci and John Hermle cite findings from a recent KPMG study on the impact of the credit crisis on fund managers that highlights investors’ recent skepticism toward the most complex structured financial instruments and points to the need for fund management firms to build up more robust risk management capabilities. Sue Allon joins the recent debate over the role that the FASB’s recent fair value accounting rules have played in the severe mark-downs of MBS and collateralized debt obligations on financial institutions’ balance sheets, and proposes one possible solution to the problem: that a distinction be made between truly credit impaired securities and those that are just liquidity-impaired; the latter would not be subject to mark-to-market accounting.

Two articles follow on Islamic securitization, one of the fastest-growing sectors of structured finance today. Andy Jobst discusses the conflicts of interest, agency costs, and other weaknesses of securitization brought to light by the credit crisis, reviews the distinction between conventional and Islamic financial principles in the context of securitization, notes that many of the pitfalls that contributed to the U.S.subprime crisis are relevant to Islamic finance as well, and discusses current economic and legal challenges confronting the Islamic securitization market. S.R.Vishwanath and Sabahuddin Azmi provide a brief history of the development of sukuk, which are asset-, project-,or service-backed fixed-income vehicles, give us an overview of the current sukuk market, compare sukuk with conventional bonds, explain the structure of the most common types of sukuk, and include case examples of ijarah, musharakah, mudarabah, murabaha, and salam sukuk.

We conclude the issue with two articles on infrastructure financing. Abu Chowdhury, Ryan Orr, and Daniel Settel show how private equity structures have become an important point of access for multilateral development finance institutions (MDFIs) into infrastructure project investments in emerging markets; typically the investment dollars put to work in those funds flow into public private partnerships, project financing, and infrastructure-enabling companies. These infrastructure fund investments may serve as a bridge for MDFIs to learn about private equity investing strategies and opportunities. Then Bruce Graham comments on the recent slowdown in municipal infrastructure financing as a result of the financial crisis, and cites some recent examples of creative structured finance techniques to move projects forward that otherwise would be stalled such as identifying alternative revenue streams, tax sharing, and retooling existing credit enhancement. We will have more articles addressing basic causes of the financial crisis and the future direction of structured finance in the Spring issue. Stay tuned.

Henry A. Davis

Editor

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