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Connecting the Dots: US SEC, ABS Mandates,
Financial Modeling and Python
Presented by
Ann Rutledge, R&R Consulting
Diane Mueller, ActiveState
Speakers
• Ann Rutledge
• R&R Consulting
• Diane Mueller
• ActiveState
Founded 1997
2 million developers, 97% of Fortune 1000 rely on
ActiveState
Development, management, distribution solutions
for dynamic languages
Core languages: Python, Perl, Tcl
Other: PHP, Ruby, Javascript
About ActiveState
We’ve got your universe covered
About R&R Consulting
• R&R Consulting is a 10-year-old leader in cybernetic finance
• A standards firm for debt capital markets
• Balanced emphasis on risk-responsibility and value creation at each
link in the global supply chain of debt capital
What we will cover
• eGov & the Appearance of Transparency
• Case Study: Financial Content at US SEC
• Why Reg AB was not enough
• Python & Financial Models – the next Wave
Premise
• “Open” Gov’t Data needs “Open” Tools
• Tool Vendors need Open Source technologies
– Expedite delivery of consumption tools to market
– Ensure consistency in interpretation of the data
– Ensure equal access to tools across the supply
chain
So what is eGov?
• The way in which government has to adapt itself to a world in
which most people regularly use the internet
– http://poit.cabinetoffice.gov.uk/poit/
Motivation
• Transparency and engagement
– holding government accountable and promoting choice by
informing citizens
• Efficiency and enhanced public services
– enabling re-use of information within the public sector
• Innovation and economic growth
– encouraging and supporting data-driven innovation
eGov in US: Open Government Directive
January 2009
• President Obama issued a
memo on transparency
directing his top officials to
develop plans for an Open
Government Directive to
promote transparency,
participation, and
collaboration.
Growing availability of Open Gov Data
• US, UK, Australia,
Netherlands, Denmark,
Sweden, Spain ...
• Washington, Madrid, London,
Vancouver, ...
Publishing Data on Data.Gov
• XML
– Industry, agency, project-
specific
• RDFa
• Shape
• Excel
Unraveling Open Data
• It’s more than just documents for people to read
• Need to enable machines to
– traverse, aggregate, analyze, answer
• Tim Berners-Lee's vision of a “Semantic Web”
– "Semantics", "Ontologies”
– RDFa, Linked Data
More Context
• Open government data is a reality
– “Open” doesn’t necessarily mean:
• “Equal Access”
• “Free”
• “Transparent”
• Semantic Web is a vision
– Should be nurtured, supported and encouraged
• But we’re in the middle of a Financial Crisis
– We need to work with the tools we have now
Financial Content @ US SEC
http://www.xbrl.org
http://www.xbrlnetwork.com
• A Case Study
• Lessons Learned the hard way
Part One: The Data
XBRL @ SEC
• A standard format in which to prepare financial reports that can subsequently be presented in a variety of ways
• A standard format in which information can be exchanged between different software applications
• Permits the automated, efficient and reliable extraction of information by software applications
• Facilitates the automated comparison of financial and other business information, accounting policies, notes to financial statements between companies, and other items about which users may wish make comparisons that today are performed manually
• *Responsible* Publishing of data
• *Easier* for people to consume financial data
• *Solve* some snags other approaches miss
Why did XBRL make sense for US SEC?
10 years later…
more rules, rss feeds & a viewer
It’s still a black box world
• Processing Financial Content
– requires specialized tools
– proprietary processors
• Business Decisions are all about timing
– access to data to make decision that happen in *nano*
seconds
– driven by algorithmic, computerized trading
Lesson Learned in First Phase:
Open Data at US SEC
• Appearance of transparency
• Granting of Access is insufficient
• No Open Standard API for XBRL available (yet)
• Asynchronous access to data (latency)
But what if the data isn’t enough
• A little structure goes a long way if you combine it with
– A human being with a lot of intelligence/domain
knowledge
– (tools, protocols, means of communication)
– (browser, http, share)
• Complex legalese in Filings & Prospectuses
– Logic embedded in them needs to be interpreted
http://benbittrolff.blogspot.com/2008_12_07_archive.html
Off to the Next Crisis
Enter the Financial Ninjas
http://en.wikipedia.org/wiki/Subprime
_crisis_impact_timeline
Seeds of the Latest Crisis
• Industry participants have real problems interpreting how the
cash flow is allocated
• The lack of certainty creates serious valuation problems for
holders of the securities
• Investors and their custodians also have very real settlement
problems
Regulators/Watchdogs
Assets
• Corporate credit is stochastic: YES/NO. ABS is statistical, not stochastic: YIELD/% OF PAR?
• Corporate data disclosures are public. ABS data disclosures are private.
• Corporate data are a moving target—ratios change with business flows. ABS credit-sensitive data is taken on a static pool basis.
• Corporate disclosures are a snapshot of performance, easily “doctored.”ABS data should be updated: when the pool amortizes, so does risk.
Liabilities/Capital Structure
• WYSIWYG/Not WYSIWYG.
• Deal waterfalls defines value.
• To implement the standard form or defined amortizations, modeling skills and knowledge of finance are required.
• Waterfalls are not always unidirectional (as we intuit them). Some are complex, with recursions and nonlinearities.
• At origination, Sellers and Buyers are supposed to be risk-neutral. Modeling mistakes totally change the game.
Credit Ratin
gs
ABS is the new black box
How a Deal Waterfall Works, Conceptually
• The whole thing is a state machine that needs to be precise in every detail; as generally once the deal is set up, the trustees and managing agents have no discretion
• They have to follow the script precisely as set out in the deal prospectus
Sample Waterfall (AmeriCredit 2001)
26
Copyright 2010
What Real Waterfalls Look Like
(This One Has Loops)
Copyright 2010
Distribution Structure:
Calculate Available Funds
using the SWAP Payment
and Yield Maintenance Cap.
The result will be distributed
across all tranches in the
liability structure.
Allocation Structure:
Use a Trigger to determine,
“Which Allocation Plan do I
call, A or B?”
Trigger
Sample Waterfall (Bear Stearns 2005)
Here, the Master Waterfall Has A Trigger
28
Sample Waterfall (Bear Stearns 2005)
Distribution
…If Tripped, Pro Rata Becomes Sequential
…Mezzanine Class Credit Enhancement Is
Linked to 60+ Delinquencies
A simple difference linking two
complex calculations: 60+
days’ delinquent accounts as a
percentage of the current pool
balance and a run-rate target
enhancement percentage.
Sample Waterfall (Bear Stearns 2005)
Asset Trigger Event
Enter Regulation (“Reg”) AB
The necessary, robust disclosure framework developed by the
SEC for structured securities.
• Necessary because:
– ABS use different (private data) and different measures (static pool
delinquencies, defaults, losses)
– ABS have a different risk/return profile than corporate debt
securities—the risk amortizes as the pool amortizes
• Robust because:
– Reg AB incorporated all key disclosure items as recommended by the
market
– It was strongly endorsed by large pension funds and institutional
investors
Why Reg AB was not enough..
Regulation AB: Evolving, Closing
Loopholes
2005 Version
• Requires disclosure of static pool
data in prospectus, website
disclosure of performance data
– Delinquency
– Loss
• Sets a 5% standard of materiality in
misleading disclosures
2010 Proposal
• Requires updated disclosures.
• Lowers the threshold of materiality
to 1%
• No shelf registration without risk
retention
• Waterfalls must be published, as
part of the data set
Disclosure,
Feedback,
Enforcement
How Access to Financial Models
helps..• Today, it’s hard to Price Securities
– complex prospectus documentation
– write your own waterfall program
– data must be mined from investor reports
– determine the cash flow every month
• Proprietary analytic packages that do this, but it’s expensive
– pay 100K USD for the model to find out the securities are fairly priced
• Having the model & updated data freely means:
– Securities can be valued in a far more cost effective way
– Leaves less up to interpretation
– Run scenario’s on the portfolio and access the impact on the underlying
securities in real time
http://www.sec.gov/rules/proposed/2010/33-9117.pdf
What is the SEC asking for?
• Python code to document the waterfall model
– decision logic which determines the cash payouts made to
all the securities attached to the a specific mortgage pool.
– depending on specific events the cash flows distributed to
securities will change over time based on events occurring
in the underlying portfolio
• This is documented in the prospectus which can be > 600
pages of detailed legal language
http://www.pylaw.org/demonstration.txt
Why Python makes sense for US SEC
• Open Freely Available now
• Available libraries for working with complex algorithms
– Numpy, matplotlib, Rpy
• Bindings exist for other proprietary numerical Financial libraries
• Already widely used for Financial Modeling
• Python is a very readable language when coupled with the other proposal that detailed asset level data be also provided in machine readable (XML) format
http://jrvarma.wordpress.com/2010/04/16/the-sec-and-the-python/
Next Steps
• Key: Give Feedback to SEC on it’s Proposal
– Depends upon economics, politics, culture and
technology
– Which could easily change in radical ways..
• Through an invention
• Through a insight into a practical application of an existing
technology
• Fostered by Open Collaboration, Open APIs
It’s still a black box world
• Collaboration across constituencies..
– “Open” Gov’t Data needs “Open” Tools
• Open Source technologies
– Expedite delivery of consumption tools to market
– Ensure consistency in interpretation of the data
– Ensure equal access to tools across the supply chain
Q & A
www.activestate.com
Twitter: @activestate
www.creditspectrum.com
Twitter: @annrutledgerr
Thank You
Speak to a representative about
ActivePython Enterprise or OEM: 1-866-510-2914
www.activestate.com
