Significant Risk Transfer: Market, Structures, Economics and Risks

Vinod Kothari and Dayita Kanodia | Finserv@vinodkothari.com 

Introduction

Known by various alternative names as “synthetic risk transfers”, “credit risk transfers”, “on balance sheet securitisation” or “synthetic securitisation”, Significant Risk Transfers (SRT) have a history of over 25 years but have recently grown faster than other components of either traditional securitisation or credit derivatives.  The pool value of banks’ synthetic securitizations has surpassed $670 billion, and the global sales of SRTs are expected to expand 11% annually on average over the next two years. 

This article discusses SRT Transactions, the state of the market, different structures used, risks, capital benefits, and the regulatory permissibility of such transactions in different countries. Finally and quite significantly, this article makes a case as to why India, which is one of the very countries in the world presently prohibiting such structures, should rethink.

Market Overview

As per a report published by the International Association of Portfolio Managers, by the end of 2024, over € 700 bn of securitized loans were protected by $ 75 bn (9%) of SRT tranches, some 70% being issued by European banks. Further, the International Association of Credit Portfolio Managers reported that between 2016 and 2023, nearly 500 SRT transactions protected underlying portfolios adding to $ 1 trillion in loans, ranging from corporate loans to auto loans. 

Period 2016- 2024 portfolio under SRTs totaled Euro 1311 billion (or roughly USD 1500 billions). In 2024, Europe, excluding the UK, took Euro 152 billion out of the Euro 260 billion protected portfolio. 

Thus, nearly half of the SRT deals have originated from EU countries. The proportion was even larger historically, but US banks started aggressively getting into SRT Transactions in 2025. 

SRT transactions have existed even before the Global Financial Crisis. In 2021, EU regulators extended the benefit of lower regulatory capital consuming “simple transparent and standard” (STS) securitisation treatment to synthetic transactions too. This has proved to be the game changer.

Asset classes

While corporate loans still represent almost two-third of the underlying pool assets (63%) in 2024, composition of other asset classes were: SMEs (13%), auto loans (7%), residential mortgages (3%), and specialized lending (3%). As in the past, in 2024 some 80% of issued synthetic securitizations support commercial lending to Corporates and SMEs. 

Investors

Specialised credit funds, aka private credit funds,  and debt fund managers are the largest investors. The following graph shows the composition of SRT investors: 

Some Recent transactions

The following are examples of some of the recent SRT transactions:

Banco Santander IFC transaction (2024)

The International Finance Corporation (IFC), a member of the World Bank Group, announced that it will provide a credit guarantee of $93 million to Banco Santander Mexico so that it can allocate more resources to financing small and medium-sized businesses (SMEs) in the country.

Aareal Bank (2025)

Aareal Bank, a German Bank completed its first SRT transaction, synthetically referencing a portfolio of performing European commercial real estate loans. With this transaction, Aareal Bank offered investors an opportunity to take exposure to a €2 billion CRE portfolio, which is equivalent to approximately 6 per cent of Aareal Bank’s overall CRE portfolio. 

Basic Structure of SRT 

Synthetic securitisation uses credit derivatives or similar devices to transfer the risk of a mezzanine tranche(s) of the credit risk of a pool of assets to capital markets by embedding such risk into credit-linked securities. The word “synthetic” is used in distinction to a traditional securitisation, which may be called “cash securitisation” or “true sale securitisation”. In every traditional or cash securitisation, there is a pooling of credit assets to constitute a reasonably diversified pool. The pool is then tranched into multiple tranches, such that, usually, the first loss tranche is retained by the originator, and mezzanine and senior tranches are moved to capital markets through a special purpose vehicle. The result is funding as well as risk transfer. The first loss piece, retained by the originator, neither leads to funding, nor risk transfer. However, for the mezzanine and senior tranches, there is a movement of money from the investors to the originator through the SPV, and risk transfer in the opposite direction. In synthetic securitisation, the purpose is not funding: the purpose is risk transfer. Therefore, the first loss piece still typically stays with the originator, but the risk in the mezzanine is moved to capital markets through the issue of credit-linked securities. The transfer of risk, without funding, may happen using credit default swaps, or guarantees

Structural Variations 

SPV versus non-SPV structures

Over three-quarters of the reported trades in 2024 are issued without SPV. The percentage of protected tranche notional issued directly by banks increased from some 25% in 2016 to 73% in 2024.

SPV Structure:

In the case of an SPV structure, an SPV is brought in as an intermediary between the investors and the originator. In case of cash or traditional securitisation arrangements, an SPV is brought in to hold the assets as a repository for the investors. In synthetic structures, there is no transfer of assets at all, an SPV is commonly used for the following reasons: 

1. The funding raised by the investors is held and invested by the SPV. If there were no SPV, the funding would be held by the Originator, which would expose the originator to a counterparty risk as the originator would become the obligor for the securities. 
2. Further, the rating of the securities would consequently be capped at the originator’s rating due to the counterparty risk in case of an SPV structure.
3. If the SPV was not there, the originator would issue the securities, which may impose withholding tax requirements on the originator. Which is why, typically for a cross border issuance, the SPV is located in a tax haven jurisdiction that will avoid tax implications. 

The structure of SRT transactions has not changed from what it was before the GFC.  For example, n December 2001, DBS Bank Singapore introduced its first synthetic securitisation transaction involving a reference portfolio of approximately S$2.8 billion of corporate loans. The transaction used credit default swaps to transfer credit risk to an SPV, ALCO 1 Limited, without a true sale of assets. The SPV issued around S$224 million of multi-currency, multi-tranche notes (rated from AAA to BBB), while DBS retained the first-loss and super-senior exposures. The deal enabled regulatory capital relief and risk-weighted asset optimisation, and is widely regarded as one of Asia’s earliest synthetic CLO-style transactions outside Japan, marking a milestone in regional structured finance markets. Although this transaction was undertaken more than two decades ago, the structure used primarily remains the same. The following diagram illustrates a common SRT SPV structure:

Non – SPV Structure:

As explained above, typically an SPV is required in cash or traditional structures for holding the asset, isolating it from the originator, protecting the assets from bankruptcy risks of the originator. A rating arbitrage, that is, any of the securities of the SPV being rated higher than the originator, is not theoretically possible if any of the securities represent a claim against the originator. In synthetic structures, there are no actual assets, only synthetic; therefore there is no need to protect the assets (meaning assets of the investors). However, synthetic CDOs do have assets to the extent of funding contributed by the investors. If this funding were to be prepaid or invested in the originator the claims of the investors are backed up by the claim against the originator, and hence, are subject to the rating cap of the originator. 

It is understandable that the cash assets of a synthetic structure is only a fraction of the synthetic assets and hence the need for originator bankruptcy isolation is less prominent. A number of synthetic transactions have found it less necessary to involve a facade between the originator and the investors and have gone ahead with non- SPV structures. In this structure, the securities are issued by the originator himself and therefore represent a claim against the originator. 

There are various Non-SPV structures observed in the market, Unfunded bilateral guarantee/CDS with no SPV, Funded bilateral guarantee/CDS with no SPV, Funded Credit Linked Note issued by originator with no collateral. 

The table below shows the difference between SPV and Non-SPV structures:

	SPV Structure	Non-SPV Structure
Counterparty risk	In the case of an SPV structure, the entire money paid by the investors will be held by the SPV. This ensures that the investors are protected from the counterparty risk w.r.t the originator since any amount paid by them is held by a bankruptcy remote vehicle.	In this case, the investor will be exposed to both the risk of default in the assets as well as counterparty risk of the originator, as opposed to the SPV structure, where the counterparty risk is eliminated.
Rating Cap	The SPV is a separate bankruptcy remote entity, and hence no cap on rating because of the counterparty risk of the originator.	The rating of the securities will be capped at the rating of the originator due to counterparty risk.

Other structures

1. Blind portfolio structures

In a blind reference pool SRT, the bank does not reveal borrower details to the investor or protection provider, and the investor only has access to high-level characteristics of the reference loan portfolio (such as industry distribution, credit ratings, or geographic exposure). Under this type of structure, investors face higher uncertainty as they must rely on the bank’s understanding of standards and risk management practices instead of conducting their own loan-level risk analysis. 

2. Funded Structures

In case of funded structures, the originator and the investor enter into a bilateral credit protection contract which may be drafted as a guarantee or a credit derivative. The investor then places a collateral equivalent to the maximum payment obligation under the contract. The money from this collateral amount deposited is only paid to the originator when losses hit the protected tranche. The collateral amount remaining after absorbing the losses is returned to the investor. 

3. Unfunded structures

Unfunded SRTs are transactions not secured by financial collateral. The investor (protection provider) does not make any upfront payments to cover potential losses and is only required to compensate the bank if a credit event occurs. The protection provider is considered to have a high enough credit quality to mitigate the counterparty risk and is subject to eligibility criteria in Europe. The protection providers are typically, in Europe, insurance companies, pension funds, or multilateral development banks. The bank originating the SRT is exposed to counterparty credit risk.

4. SRT with replenishment period

SRTs with a replenishment period allow a bank to add new loans to the loan portfolio as old loans mature, subject to eligibility criteria. Typically, the loans will come from the same portfolio and share the original loan’s credit characteristics. The risk for the investor is potential asset quality deterioration of the reference pool, as the likelihood of credit losses could increase from lower asset quality loans being added, or from changes in the risk profile of the reference pool.

Economics of Risk Transfer

Consider a room with bombs placed in 5 different regions, as opposed to all the bombs placed in one place. The probability of a person stepping on the bomb will be far less in the first case than in the second one. The same is the case with assets. 

The economics of risk transfer in securitisation are rooted in the principles of integration and differentiation that underpin structured finance. A diversified set of underlying assets is first aggregated into a single pool, enabling risk to be spread across a broader portfolio rather than remaining concentrated at the individual loan level. This pooled risk is then differentiated through tranching, whereby cash flows and credit risk are allocated among distinct tranches with varying risk-return profiles. Such structuring facilitates more efficient risk allocation and diversification, making the protection buyer better off as compared to obtaining guarantees or credit protection on each loan on a standalone basis, where risk remains fragmented and less efficiently distributed. 

Thus, integration and differentiation ensure that correlation risk, or the risk that other assets also default on a default by one asset, is minimal. 

Risks of SRT

The following are some of the risks associated with SRT Transactions:

1. System-wide leverage and risk migration
   SRTs transfer credit risk from banks to non-bank financial institutions (notably hedge funds and credit funds) that are typically less constrained by capital requirements and can employ higher leverage. This can increase aggregate leverage in the financial system, even if bank balance sheets appear safer. In many cases, banks also provide leverage to SRT investors, meaning part of the risk may remain indirectly within the banking system.
2. Interconnectedness and contagion risk
   By redistributing bank-originated credit risk across banks, asset managers, hedge funds, insurers, and custodians, SRTs deepen inter-sector linkages. The private and opaque nature of many SRT deals makes it harder for supervisors to map exposures, raising the risk that stress in one segment (e.g., leveraged funds) propagates rapidly across the financial system.
3. Investor concentration and rollover risk
   The SRT investor base is highly concentrated. Credit funds and asset managers account for a majority of demand, with a small group of large investors holding a dominant share of outstanding exposure. Further, since SRT maturities (typically 3–5 years) are often shorter than the underlying loan tenors, banks face rollover risk that is if investor appetite dries up, banks may experience a sudden increase in RWAs, capital pressure, and higher funding costs.
4. Weaker underwriting incentives over time
   Strong demand for high-yield SRT tranches may attract more risk-tolerant investors, encouraging aggressive deal structuring or looser credit standards. Increased competition for SRT issuance can lead to sub-par due diligence, potentially worsening the quality of underlying loan pools and increasing vulnerability to credit shocks.

Regulatory capital

In an SRT transaction, a bank buys protection for the mezzanine tranche by issuing CLNs to investors. Under securitization treatment, the senior tranche carries 20 percent RWA, and the first-loss tranche carries 1,250 percent RWA. The RWA for the mezzanine tranche becomes zero because the bank is no longer exposed to the losses from this tranche.

The following examples illustrates maintenance of capital in case of SRT vs non-SRT transactions:

Non-SRT (in USD million)		SRT (in USD million)
Asset Pool	100	Asset Pool	100
RWA ratio	50%	First Loss Tranche %	0.50%
RWA	50	RWA ratio	1250%
Tier 1 Capital	10.50%	RWA	6.25
Tier 1 Capital Required	5.3	Mezzanine Tranche %	4.50%
		RWA ratio (as risk transferred, backed by cash)	0%
		RWA	0
		Senior Tranche	95%
		RWA ratio	20%
		RWA	19
		Total Capital Required	2.7

Thus, the capital required to be maintained in case of SRT structures is significantly lower as compared to non-SRT structures thus allowing originators capital relief. This, however, is a function of the size of the junior tranche. In the same example as above, if the thickness of the junior tranche was 3%, the required capital would have gone up.

Regulatory Permissibility of SRT

In India, synthetic securitisation, which is defined as a structure where the credit risk of an underlying pool of exposures is transferred, in whole or in part, through the use of credit derivatives or credit guarantees that serve to hedge the credit risk of the portfolio, which remains on the balance sheet of the NBFC, is prohibited. [para 5(3) of the Reserve Bank of India (Non-Banking Financial Companies – Securitisation Transactions) Directions, 2025]. Accordingly, SRT transactions where there is only a transfer of the risk and rewards without the transfer of the asset are prohibited in India. 

The below table shows the regulatory permissibility of SRT in various jurisdictions:

Countries	Regulatory Permissibility of SRT
India	Prohibited
Australia	Not eligible for capital relief
UK	Permissible
Hong Kong	Permissible
Canada	Permissible
Indonesia	Prohibited
China	Prohibited
Japan	Permissible within regulatory limits
EU	Permissible
Korea	Prohibited
Singapore	Permissible

Over the years, SRTs have become a very potent tool for regulatory capital and risk management. SRTs have also permitted private credit funds to acquire exposure on loan portfolios without organically creating them. The regulatory antipathy for synthetic securitisation was the multiple layers of risk transfers as seen during the GFC. This was, however, more in case of structured finance CDOs and arbitrage transactions. SRTs are currently mostly related to on-balance sheet assets – hence, the question of any unwarranted risk transfers or risk build up do not arise. Of course, any securitisation transaction creates an interconnection between the banking system and capital markets, but that is also a cushion against risk as it has a potential for risk of contagion. 

Bibliography

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