Source: https://www.cadwalader.com/resources/clients-friends-memos/sec-proposes-significant-enhancements-to-regulation-of-asset-backed-securities
Timestamp: 2019-04-26 14:40:52+00:00

Document:
On April 7, 2010, the Securities and Exchange Commission (the “SEC”) released proposed rules (the “Proposed Rules”) that would significantly revise Regulation AB (“Reg AB”) and other laws governing offerings, sales and reporting for asset-backed securities, including mortgage-backed securities (“ABS”), and would significantly broaden the range of transactions covered by such regulations.1 Reg AB was initially adopted in January 2005 and established a tailored set of rules governing the issuance of ABS. Reg AB was adopted some 8 months after it was initially proposed by the SEC, following an industry comment process, with an effective date of March 8, 2005.2 Although the SEC adopted Reg AB to “address comprehensively the registration, disclosure and reporting requirements” for ABS,3 the perceived role of ABS in the recent financial crisis has caused the SEC to re-think the regulation of the ABS markets just over 5 years after the initial effective date of Reg AB.
Among other things, the Proposed Rules require detailed loan-level disclosure for most ABS (which the SEC declined to do in the original Reg AB4), revamp the process for registration of ABS and condition the availability of certain exemptions from registration for “structured finance products” (which is a newly-introduced definition that is broader than “asset-backed security”) on the availability of disclosure equivalent to that required in an SEC registered offering of those instruments, thus regulating the private securities market in an unprecedented way.
revising safe harbor provisions for privately-placed ABS.
This memo summarizes the Proposed Rules and analyzes some of the effects the rules would have on the ABS market if enacted by the SEC in their proposed form.
a perpetual Exchange Act reporting obligation.
These criteria are only applicable to securities registered on a shelf registration statement and do not apply to securities registered on a stand-alone basis or to privately offered securities (in each case, with the exception of the proposed Rule 144A ongoing information requirements described below), although registration of securities on a stand-alone basis would subject them to a longer review period since the new registration statement would need to be filed and would be subject to review and comment by the SEC.
In each case, the sponsor’s exposure must be net of any hedge that directly relates to the securities or exposures taken; however hedge positions that relate to overall market movements, such as interest rates, currency exchange rates or the overall value of a particular broad category of ABS, would be permitted.
Note: The reference to hedges that relate to “the overall value of a particular broad category of ABS” appears to be a specific reference to hedges using indices such as the ABX or CMBX. This type of sector-specific hedging would not insulate a sponsor from the specific credit risk of aggressive underwriting of assets in a particular transaction, and therefore would not undermine the SEC’s objective of encouraging disciplined underwriting of assets to be securitized. As long as a sponsor underwrites assets in accordance with standards that reflect the broader market, it should be able to hedge general market risk.
The economic interest required to be retained is measured at issuance (or origination, in the case of the originator’s interest) and is required to be maintained as long as non-affiliates of the depositor hold any of the issuer’s securities sold in the offering.
Note: The SEC stated that it considered the impact of the risk retention requirement on financial reporting consolidation under the newly issued Financial Accounting Standards No. 166 and 167, but noted that although risk retention would give the retaining party a variable interest in a variable interest entity, that feature alone, without the right to direct the activities of the variable interest entity would not by itself give the retaining party a sufficient “controlling financial interest” that would result in consolidation. Nevertheless, the impact of risk retention on financial reporting consolidation will need to be considered on a deal-by-deal basis.
2. Quarterly Third-Party Opinion Regarding Repurchase Obligations: The SEC is concerned about ensuring that the representations and warranties given by originators and sponsors about the assets in a securitization pool provide meaningful protection to investors, thereby encouraging sponsors to include higher quality assets in their pools. The Proposed Rules therefore require that, as a condition to shelf eligibility, the party making representations and warranties will be obligated to furnish a third-party opinion regarding any asset as to which the trustee has alleged a breach of a representation and warranty, but which was not repurchased or replaced because the representing party asserted that the asset did indeed comply with the representation or warranty. The third-party opinion would be required to confirm that the asset did not violate a representation or warranty in the pooling and servicing agreement or other transaction document, and would be required to be furnished to the trustee on a quarterly basis.
Note: The SEC did not specify what sort of third-party would be required to give such an opinion, although it does request comment on whether such opinions should be rendered by lawyers or third-party diligence firms. The SEC also failed to specify any standard under which the question of whether or not a breach has occurred should be analyzed. Contractual disputes rarely arise in instances where the language of a contract is clear and incontrovertible. Perhaps an appropriate standard might be that the party declining to repurchase an asset in response to an alleged breach has a reasonable good-faith position that a breach has not occurred or some other standard short of an unqualified opinion that there has been no breach.
Note: The Proposed Rules are not proposing that a sponsor or originator make any specific representations or warranties nor do the Proposed Rules propose any specific remedies for a breach of a representation or warranty. The Proposed Rules are focused on enhancing the enforcement of the contractual remedies that are already included in the transaction documents.
Note: The proposed certification, as written, could be read to address the adequacy of required cash flows on the underlying securitized assets to make promised payments on the ABS to be issued, rather than the likelihood that the underlying obligors will perform in accordance with their payment obligations. However, the words “taking into account internal credit enhancements” (as well as the request for comment as to whether, in the alternative, the sponsor should be required to disclose its estimates of default probability for all tranches in the transaction) indicate that the SEC does intend for the statement to address the credit quality of the underlying securitized assets.
Note: Although the Proposed Rules would add significant new eligibility criteria to the use of a shelf registration statement for ABS, the elimination of the investment grade ratings criterion would, for the first time, allow certain below investment grade tranches of ABS deals that were previously offered in simultaneous private offerings to be conveniently registered on a shelf basis.
To enhance compliance with the new eligibility criteria, the Proposed Rules provide that if a registrant is not currently holding the required retained risk or has not been in compliance with the other filing/reporting requirements for the last 12 months with respect to previous offerings, it will not be eligible to register securities on a shelf registration statement. See “Additional Requirements for Using Form SF-3” below.
Note: The extension of Exchange Act filing requirements for the life of an ABS deal also extends the requirement for annual Sarbanes-Oxley certifications, annual servicer compliance statements, assessments of compliance with servicing criteria, accountant attestations and other required reports for the life of the transaction. This requirement, combined with the possibility of loss of shelf eligibility for failure to timely file required reports, will increase the burden on sponsors of securitizations to monitor the ongoing reporting apparatus for transactions, and may be perceived as raising the barriers to entry into the ABS markets for smaller lenders.
One Depositor/One Asset Class per Registration Statement: To facilitate investor understanding and access to prospectuses, the Proposed Rules restrict each Registration Statement to a single depositor and single asset class. This proposal would eliminate the current practice of registering multiple base prospectuses and prospectus supplements on a single registration statement to accommodate different asset classes.
Note: The SEC has indicated that resecuritizations are a separate asset class from the underlying security and, therefore, that the resecuritization ABS and the underlying ABS would need to be registered on separate registration statements even if the depositor is the same.
Additional Requirements for Using Form SF-3.
An ABS issuer wishing to conduct a takedown off of an effective shelf registration statement would be required to evaluate on a quarterly basis whether it complied with the proposed new eligibility requirements as of the last day of the most recent fiscal quarter.21 This would require the issuer to confirm once a quarter that it remains eligible under the effective registration statement.
Note: The Proposed Rules do not condition shelf eligibility upon a sponsor or its affiliates retaining unhedged risk from prior ABS securitizations of assets of the same class at all times, but rather that the sponsor or affiliate held the required risk (i) on the last day of the most recent fiscal quarter and (ii) at the time of filing the new registration statement.
Note: This new requirement to file preliminary prospectuses 5 days prior to pricing will significantly affect the timetable utilized in public offerings of ABS in some markets. In markets where it has not been typical to utilize preliminary prospectuses (e.g., the prime RMBS market), it will now be necessary to prepare preliminary prospectuses, which will impact the time required to execute such transactions. Even in markets where the use of preliminary prospectuses is typical (e.g., the CMBS market), the requirement that a revised preliminary prospectus reflecting any material change in information reflected in the previously filed preliminary prospectus, other than pricing information, be filed 5 days prior to pricing could slow down the offering process substantially.
Note: The ability of ABS issuers to access “pay-as-you-go” pricing for shelf offerings is one issuer benefit provided by the Proposed Rules. This payment method, which permits issuers to pay registration fees at the time of each offering rather than up-front at the time of filing (or immediately prior to effectiveness) of a registration statement, was previously available only to so called “well known seasoned issuers,” a category of issuers that specifically excluded ABS issuers.
Requiring issuers to provide a computer program containing the flow of funds or “waterfall” in a form that would enable investors to input their own assumptions and test their own scenarios.
In proposing rules for standardized asset-level disclosure in ABS transactions, the SEC is embracing an approach that it declined to take in the original adoption of Reg AB, where it concluded that it would not be “practical or effective to draft detailed disclosure guides for each asset type that may be securitized.”32 In the Proposed Rules, the SEC has provided very detailed disclosure requirements for all the most common asset classes (other than credit card ABS and stranded cost ABS).
Some of the required data points require personal data such as geographic location, income levels and credit scores, and therefore raise significant privacy concerns. To deal with privacy concerns the Proposed Rules provide that certain data may be provided as ranges instead of specific locations or dates, for example, geographic location can be provided by referring to a more general Metropolitan or Micropolitan Statistical Area, or Metropolitan Subdivision as designated by the U.S. Office of Management and Budget.
Note: Despite the SEC's statement that the new rules would apply only to transactions after the new rules are effective, a new resecuritization would still be subject to the new disclosure requirements even though the underlying ABS may have been issued prior to the effectiveness of the new rules and might not provide for the reporting of information necessary to comply with the new requirements. Accordingly, such resecuritizations may be precluded (even in a 144A or Regulation D offering) unless the underlying ABS provides or can provide for such information. A phased approach to implementing the new requirements for resecuritizations, suggested by the SEC's request for comment, may provide some relief in this regard.
Note: The Proposed Rules require a sample of inputs and outputs to be provided to investors in order to confirm that the Waterfall Computer Program is functioning correctly. While the SEC has helpfully clarified that the sample inputs and outputs would not be construed as a representation or warranty as to actual deal performance,50 because the Waterfall Computer Program is required to be filed and incorporated by reference into the registration statement, programming errors or omissions in the program itself, at least those which produce materially misstated or misleading results, would carry the same liability as any other material misstatement or omission in the registration statement.
Material Agreement Filing Requirements. Registrants would have to file agreements or other documents required be filed as part of a registration statement by the date the final prospectus is required to be filed under Rule 424,63 although, such finalized agreements could be filed in preliminary form. The SEC noted that under current market practice, final pooling and servicing agreements are often filed after the offering has been completed.
Note: Because assessments of compliance are made on a platform level under Item 1122 of Reg AB, it is unclear how a depositor that is unaffiliated with the reporting participant in the servicing function would know that an identified instance of noncompliance relates to the assets backing the ABS covered in the Form 10-K report, unless such participant was also required to deliver a compliance statement under Item 1123 of Reg AB.
In perhaps the most significant extension of the SEC’s regulation of ABS, the Proposed Rules would regulate the level of disclosure to be provided in ABS transactions that are offered pursuant to Rule 144A and Regulation D. In proposing these rules, the SEC seems to have concluded that even relatively sophisticated classes of investors, such as qualified institutional buyers and accredited investors, require the protection of SEC-mandated levels of disclosure by requiring that transactions offered under these exemptions from the registration requirements of the Securities Act nonetheless provide, upon request, all of the disclosure that would be available for transactions offered pursuant to a registration statement.
Note: Read literally, the new requirements for the Rule 144A safe harbor would require not only ongoing reporting of asset performance information with respect to structured finance products, but the full range of information required to be contained in periodic reports for asset-backed securities transactions under the Exchange Act. Absent further clarification from the SEC, information required to be provided could thus include annual servicer compliance statements, assessments of compliance with the servicing criteria of Item 1122(d) of Reg AB, accountant attestations and all other information required to be reported on or to accompany Forms 8-K, 10-D and 10-K with respect to public ABS.
The new exemption requirements for private transactions apply only where there is reliance on the safe harbors in Rule 144A and Regulation D. Transactions that rely solely on the statutory exemption contained in Section 4(2) of the Securities Act, or on the so-called "4(1-½)" exemption, would not need to comply with the new requirements.
Note: Asset-backed commercial paper is often issued in reliance on the Section 4(2) private placement exemption and the so-called “4(1-½)” exemption for private resales, so these transactions may not be affected by these additional disclosure requirements.72 It is unclear whether these new informational requirements will have the result of pushing certain other ABS transactions out of the Rule 144A and Regulation D market into the so-called “pure” private placement market, with its more significant restrictions on the manner of offering. This may be the only option for securitizing assets where the information required to be disclosed by the Proposed Rules is simply not available.
Note: It is not clear to what extent the requirements of Reg AB, including the requirement to provide loan level disclosures, would apply to “structured finance products” that are not “asset-backed securities,” although the SEC would presumably require many comparable disclosures in connection with its review of Form S-1 registration statements for such products.
1 See Asset-Backed Securities, SEC Release Nos. 33-9117; 34-61858, File No. S7-08-10, Proposed Rule (April 7, 2010), available at http://www.sec.gov/rules/proposed/2010/33-9117.pdf.
2 See Asset-Backed Securities, 70 Fed. Reg. 1506-1631, at 1506 (January 7, 2005), available at http://www.sec.gov/rules/final/33-8518fr.pdf.
3 See Id. at 1507.
4 See Id. at 1509.
5 See Proposed Rules at 13.
6 See Proposed Rules at 22.
7 However, with respect to resecuritizations, the SEC has indicated that loan-level disclosure requirements would apply to the assets underlying the resecuritized securities, regardless of whether those securities were issued prior to the effective date.
8 See Form S-3, General Instructions (I)(B)(5).
9 See Proposed Rule 17 C.F.R. § 239.45(b)(1)(i)(B) at 506 and Proposed Rules at 49.
10 See Proposed Rule 17 C.F.R. § 239.45(b)(1)(iii) at 507 and Proposed Rule 17 C.F.R. § 229.601(b)(36) at 373.
11 See Proposed Rules at 71.
12 See Proposed Rule 17 C.F.R. § 239.45(b)(1)(iv) at 507.
13 See Proposed Rules at 38; proposed Form SF-1 at 492 and proposed Form SF-3 at 503.
14 See Proposed Rules at 16; 17 C.F.R. § 239.11 at 489 and 17 C.F.R. § 239.13(b)(5) at 491.
15 See proposed Form SF-3, General Instruction (IV) at 520.
16 See Proposed Rules at 99.
17 See proposed Form SF-3, General Instructions (I)(A)(1) at 511.
18 See proposed Form SF-3, General Instructions (I)(A)(2) at 511-512.
19 See proposed Form SF-3, General Instructions (I)(A)(3) at 512.
20 See Proposed Rules at 40 and 17 C.F.R. § 239.45(a)(2) at 504.
21 See Proposed Rule 17 C.F.R. § 230.401(g)(4)(i) at 471.
22 See Proposed Rule 17 C.F.R. § 230.430D(a)(1) at 474.
24 See Proposed Rule 17 C.F.R. § 230.430D(a)(2) at 475.
25 See Proposed Rule 17 C.F.R. § 230.424(h) at 473-474.
26 See Proposed Rules at 31.
27 See Proposed Rules 17 C.F.R. § 240.15c2-8(b) at 536 and Proposed Rules at 91.
28 See Proposed Rule 17 C.F.R. § 230.456(c)(1)(i) at 481.
30 See Proposed Rule 17 C.F.R. § 230.456(c)(1)(ii) at 481.
31 See Proposed Rule 17 C.F.R. § 229.1111(h) at 383. The SEC is proposing to exempt ABS backed by stranded costs from the obligation to provided asset-level data. Stranded costs are certain capital costs incurred by public utilities which are permitted, by action of a state legislature or other regulatory authority, to be recouped over time from rate payers.
32 See page 1509 of the adopting release for Regulation AB (Release Nos. 33-8518 and 34-50905).
33 See Proposed Rule 17 C.F.R. § 229.1111A Schedule L at 385-423.
34 See Proposed Rules at 135 and 143.
35 See Proposed Rules at 149.
36 See Proposed Rule 17 C.F.R. § 229.1111A Schedule L, Item 11 at 423.
37 See Proposed Rule 17 C.F.R. § 229.1111B Schedule CC, Item 11 at 423.
38 See Proposed Rule 17 C.F.R. § 229.1111(h)(1) at 384.
39 See Proposed Rule 17 C.F.R. § 229.1111(h)(2),(3) at 384.
40 See Proposed Rule 17 C.F.R. § 229.1121(d) at 430.
41 See definition of “Asset Data File” in Proposed Rule 17 C.F.R. § 232.11 at 485.
42 See Proposed Rule 17 C.F.R. § 229.1111A Schedule L, Item 11 at 423.
43 See Proposed Rules at 182.
44 See Proposed Rule 17 C.F.R. § 229.1113(h)(1)(i) at 426.
45 See Proposed Rule 17 C.F.R. § 229.1113(h)(1)(ii) at 427.
46 See Proposed Rule 17 C.F.R. § 229.1113(h)(1)(iii) at 427.
47 See Proposed Rule 17 C.F.R. § 232.314 at 489.
48 See Proposed Rule 17 C.F.R. § 229.1113(h)(2) at 428.
49 See Proposed Rule Form 8-K, Item 6.07 at 540.
50 See Proposed Rules at 212, Footnote 349.
51 See Proposed Rule 17 C.F.R. § 232.201(d) at 487.
52 See Proposed Rules at 196.
53 See Proposed Rule 17 C.F.R. § 229.1111(a)(3) at 382.
55 See Proposed Rule 17 C.F.R. § 229.1100(g).
56 See Proposed Rule 17 C.F.R. § 229.1110(a) at 381.
57 See Proposed Rule 17 C.F.R. § 229.1104(f) at 377 and Proposed Rule 17 C.F.R. § 229.1110(c) at 381.
58 See Proposed Rule 17 C.F.R. § 229.1105 at 378.
59 See Proposed Rule 17 C.F.R. § 229.1105 at 378.
60 See Proposed Rule 17 C.F.R. § 229.1105(a)(3)(iv) at 379.
61 See Instruction to Proposed Rule 17 C.F.R. § 229.1105(a)(3)(ii) at 379.
62 See Proposed Rule 17 C.F.R. § 232.321 at 488.
63 See Proposed Rule 17 C.F.R. § 229.1100(f) at 375.
64 See proposed Form 8-K, Item 6.05 at 538.
65 See Proposed Rule 17 C.F.R. § 229.1101 at 376 and Proposed Rules at 252-254.
66 See Proposed Rule 17 C.F.R. § 229.1122(d)(1)(v).
67 See Proposed Rule 17 C.F.R. § 229.1122(c).
68 See Instruction 1 to Proposed Rule 17 C.F.R. § 229.1122 at 465.
69 See Proposed Rule 17 C.F.R. § 230.501(i) at 483.
70 See Proposed Rule 17 C.F.R. § 230.144A(d)(4)(iii) at 468 and Proposed Rule 17 C.F.R. § 230.502(b)(3) at 484.
72 See Proposed Rules footnote 455, at 272.
73 See Proposed Rule 17 C.F.R. § 230.502(b)(1) at 484.
74 See Proposed Rule 17 C.F.R. § 230.144A(a)(8) at 467 and Proposed Rule 17 C.F.R. § 230.501(i) at 483.
75 See Proposed Rules at 276.
76 See 17 C.F.R. § 229.1101(c)(1) for the definition of “asset-backed security”.
77 See Proposed Rules footnote 467, at 277.
78 See Proposed Rules at 278.
79 See Proposed Rule 17 C.F.R. § 230.192 at 470.
80 See Proposed Rules at 281.
81 See Proposed Rules at 287.
82 See Proposed Rule 17 C.F.R. § 230.144A(f) at 468.
83 See proposed Form 17 C.F.R. § 230.144A at 530.
84 See Proposed Rule 17 C.F.R. § 200.30-1(a)(11) at 366.
85 See Proposed Rule 17 C.F.R. § 232.201(a).
86 See Proposed Rules at 290.
87 See Proposed Rules at 2.
88 See Proposed Rules at 297.

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