November 5, 2009
Previously published on October 30, 2009
Draft legislation released this week by the U.S. House Committee on Financial Services would, among other things, amend the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”) to impose new regulations on securitization transactions and asset sales. The bill, released in the form of a “discussion draft,” would mandate retention of economic risk by lenders or securitizers in most whole loan sales and securitizations; provide for increased disclosure in connection with offerings of asset-backed securities (“ABS”); and permit the Securities and Exchange Commission (the “SEC”) to increase the periodic reporting requirements for SEC-registered offerings of ABS.
These provisions are part of the proposed Financial Stability Improvement Act of 2009 (the “Act”), which would address systemic risk in the U.S. financial system by creating a new oversight scheme for systemically important financial institutions.
The proposed amendments to the Securities Act and the Exchange Act appear to fall short of the new “ABS Act” called for by SEC Chairman Mary Schapiro in an address this week to the Securities Industry and Financial Markets Association. Schapiro said new legislation “directed solely at securitizations would allow Congress to specifically tailor solutions for these investment vehicles — much like the Investment Company Act of 1940.” Such a new statute, Schapiro said, could impose minimum substantive requirements on securitization transactions, such as strong representations and warranties and procedures for their enforcement, rather than merely requiring improved disclosure. “Substantive protections beyond disclosure requirements are needed for the ABS arena,” Schapiro said.
Retention of Risk
The Act would require all lenders1 that transfer loans to third parties, and securitizers of loans and other types of assets, to retain 10 percent of the credit risk on each transferred loan or other asset, unless the applicable regulator determines that a higher or lower percentage of risk should be retained, depending upon whether the “underwriting by the creditor or the due diligence by the securitizer” meets the standards to be specified by regulation or is deemed “insufficient.” The minimum retained risk percentage would be 5 percent. The required retained credit risk generally could not be hedged, directly or indirectly. The credit risk retained “must be no less at risk for loss than the average of the credit risk not so retained.” Regulations would specify the minimum duration of the required risk retention.
The Federal banking agencies and the SEC would be required to promulgate regulations implementing the legislation. The Federal banking agencies would have jurisdiction over most banking institutions and the SEC would be responsible for enforcing the regulations in all other cases. The proposed legislation does not distinguish between ABS offered in SEC-registered offerings and those exempt from registration.
The regulations could include exceptions to the 10 percent risk retention threshold or the prohibition on hedging, provided that the Federal banking agencies and the SEC “jointly” provide for such exceptions.
The risk retention requirements would apply to securitizers of “asset-backed securities,” as that term is defined in Regulation AB.2 A “securitizer” for this purpose is “the person that transfers, conveys, or assigns, or causes the transfer, conveyance, or assignment of, loans, including through a special purpose vehicle, to any securitization vehicle, excluding any trustee that holds such loans for the benefit of the securitization vehicle.”
Although it does not appear that the proposed risk retention provisions are intended to be cumulative, at least in the case of loans, the draft legislation would give the regulators, “jointly,” the ability to apply the risk retention requirements to securitizers of loans or particular types of loans “in addition to or in substitution for” the requirements applicable to originators. Thus, even if an originator of a pool of loans was required to retain credit risk, a securitizer of the same pool of loans could be subject to additional mandatory risk retention. In addition, the Act would appear to require risk retention in resecuritizations of ABS, even if the underlying loans were already subject to required retention of credit risk. However, the extent to which the risk retention requirements are intended to apply differently to securitizations of assets other than loans is unclear. The draft bill expressly requires that regulations be adopted to require risk retention by securitizers of ABS backed by assets other than loans, but most of the related provisions of the draft legislation refer specifically to loans.
New Disclosure Requirements for Rating Agencies
The Act would require the SEC to adopt regulations requiring rating agencies to include in their rating reports for ABS a description of both (1) the representations, warranties and enforcement mechanisms available to investors and (2) how those features differ from representations, warranties and enforcement mechanisms that are available to holders of similar ABS.
Periodic Reports
The Act would amend the Exchange Act to eliminate the ability of most SEC-registered securitizations to cease filing periodic reports after the trust’s first fiscal year,3 and would give the SEC authority to determine when the reporting obligation for various types of ABS may be terminated.
The draft legislation would also require the SEC to adopt regulations to expand the required content of periodic reports by ABS issuers to include information about the pool assets sufficient to “facilitate comparison of such data across securities in similar types of asset classes.” This disclosure would be required to include, at a minimum, asset-level data “necessary for investors to independently perform due diligence,” including “unique identifiers relating to loan brokers or originators, the nature and extent of the compensation of the broker or originator of the assets backing the security, and the amount of risk retention of the originator or the securitizer of such assets.”
Conclusion
It is unclear to what extent the provisions described above may be revised; the bill is expected to be marked up by the Financial Services Committee next week. In a hearing on the draft legislation before the House Financial Services Committee yesterday, Chairman Barney Frank expressed willingness to listen to input on these and other provisions of the Act, in particular with respect to the effect that required retention of risk may have on the accounting and regulatory capital treatment of asset transfers and securitizations.
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