Operational risks refer to the risk that any of the agents responsible for the various operations or processes that lead to transformation of the securitized assets into investors’ cash inflows may not do what they are supposed to do, or there might be failure of systems, equipments, or processes that may lead to leakages, costs, delays, and the like. The Basel II document defines operational risk as “the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk, but excludes strategic and reputational risk.” In the context of securitization, the term operational risk may or may not include legal risks, depending on context.

Operational issues in securitization have attracted quite some attention in recent past. The increased attention to operational issues stems from at least two reasons. First is a realization that the ultimate test of sustainability of a transaction on its own is not so much a true sale, but a true independence from the originator, in absence of which true sale loses its very meaning. The second reason is that operational issues that affect the originator’s business almost equally affect the performance of the securitization transaction as well.

A survey by Standard & Poor’s (2005a) confirms that the structured finance market regards operational risks as a major area of concern. More than two-thirds of participants identified operational risk as a major area of concern, and 78% regarded servicer quality as a major area of focus. The main area of operations in securitization is handled by servicers, and some administrative functions are handled by the trustees. In this chapter, we discuss the role of servicers and trustees and the risks inherent therein.