Keywords: Regulatory Briefing Book, SFIG, Section 15G, EHRI,
SFIG Regulatory Briefing Book Disclaimer
SFIG's Regulatory Briefing Books are designed to educate and inform our membership and other industry participants on new regulatory developments pertaining to the securitization and structured finance markets.
While our goals are to provide a comprehensive summary of all noteworthy elements for any final or proposed rules, we would caution that in most cases, these briefing books are based on a "first read" review.
In most cases they do not incorporate the benefits of any interpretive guidance or other additional information that may have been provided by the relevant regulatory agency. Nor do they incorporate the benefits of issue socialization across the full and diverse SFIG membership participants.
They are not intended to be interpreted as advocacy documents or as legal advice, or to be relied upon for anything other than initial educational purposes. There is no substitute for reading a document.
On October 22, 2014, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation ("FDIC"), the Securities and Exchange Commission ("Commission"), the Federal Housing Finance Agency ("FHFA") and the Department of Housing and Urban Development (each, an "agency")1 jointly announced that the six federal agencies had approved a joint final rule (the "final rule")2 implementing the credit risk requirements of Section 15G of the Securities Exchange Act of 1934, as amended (the "Exchange Act").
Section 15G, which was added pursuant to Section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act,3 generally requires the agencies to jointly prescribe regulations to require any securitizer4 of asset-backed securities to retain at least five percent of the credit risk of the assets supporting its securities. Section 15G also provides that such regulations shall prohibit the sponsor from eliminating or reducing its credit exposure by hedging or otherwise transferring its retained credit risk.5 Section 15G exempts certain types of assets from the risk retention requirement and authorizes the implementing agencies to exempt or establish a lower risk retention requirement for other types of assets, and to establish separate rules for different asset classes.
Over four years after the enactment of Section 15G, the final rule represents the culmination of a lengthy joint rulemaking process that had been mandated by Section 15G to occur not later than 270 days after the enactment of Section 15G.6 On April 29, 2011, the agencies issued an initial Notice of Proposed Rulemaking7 (the "original rule") implementing the risk retention requirements of Section 15G. The agencies received comments on the original rule from more than 10,500 individuals, organizations and groups, including over 300 unique comment letters. In response to those comments, the agencies issued a second Notice of Proposed Rulemaking8 (the "reproposal") on August 28, 2013, which significantly modified the original proposal, and solicited further comments on the reproposal.9
The final rule will be effective, with respect to residential mortgage-backed securities ("RMBS"), one year after the date of publication in the Federal Register and, with respect to all other classes of assetbacked securities, two years after the date of publication in the Federal Register.10
Given the length and complexity of the final rule, this regulatory briefing does not attempt to describe every important provision; rather, it is intended to summarize certain provisions of the final rule, particularly the key changes between the reproposal and the final rule.
This regulatory briefing discusses the reproposal in four parts: Part I describes the general risk retention requirement and related disclosure requirements; Part II addresses specialized risk retention options applicable to particular asset classes, including RMBS, commercial mortgage-backed securities ("CMBS"), collateralized loan obligations ("CLOs"), revolving pool securitizations, asset-backed commercial paper conduits ("ABCP conduits"), qualified tender options bonds ("TOBs"), automobile loan securitizations, commercial real estate ("CRE") loans, commercial loans, student loans and securitization transactions sponsored by the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac"); Part III addresses general exemptions applicable to particular asset classes; and Part IV addresses international transactions.
I. General Risk Retention Requirement and Related Disclosure Requirements
Generally, the sponsor of a securitization transaction must retain five percent of the credit risk of the securitized assets (determined as of the closing date of such securitization transaction), in accordance with one of the standard risk retention options described in the final rule or one of the specialized risk retention options available for specific classes of assets. The standard risk retention options include: (i) an eligible horizontal residual interest ("EHRI") option, (ii) an eligible vertical interest option or (iii) a combination of both an EHRI and an eligible vertical interest.11 In lieu of retaining an EHRI, the sponsor may cause an eligible horizontal cash reserve account to be established in an amount equal to the fair value of all or a portion of such EHRI, as discussed in more detail below.12
Despite industry comment,13 the agencies did not reinstate the representative sample option proposed in the original rule. The representative sample method of risk retention is currently one of only two risk retention options permitted by the FDIC safe harbor14 for bank-sponsored securitizations. The risk retention provisions of the FDIC safe harbor will conform automatically to the final rule, and therefore the representative sample option will no longer be available for securitization transactions complying with the FDIC safe harbor. The final rule also does not permit a sponsor to satisfy its risk retention requirement obligation by use of participation interests, unfunded credit support, companion notes or overcollateralization.15
If the agencies determine that further guidance would be beneficial for market participants, the agencies may jointly publish interpretive guidance.16 In addition, the agencies noted that market participants can seek guidance concerning the rule from the applicable primary regulator of such participant.17 If the market participant is not a depository institution, it may seek guidance from the Commission.18
A. Standard Risk Retention
1. Eligible Horizontal Residual Interest
A sponsor may satisfy its risk retention requirement by holding an EHRI, the fair value of which is to be determined using a fair value measurement framework under generally accepted accounting principles as used in the United States ("GAAP"). The final rule adopts the definition of EHRI substantially as reproposed. An EHRI is defined in the final rule as an ABS interest in the issuing entity and may be an interest in a single class or multiple classes, provided that each interest meets, individually or in the aggregate, all the requirements of the definition of EHRI. The EHRI must have the most subordinated claim to both principal and interest in the securitization transaction, and therefore shortfalls must reduce amounts paid to the EHRI prior to any other ABS. These requirements can be achieved by a variety of means, including through loss allocation, the priority of payments or other contractual provisions.19 As discussed below, the final rule excludes non-economic real estate mortgage investment conduit ("REMIC") residual interests from the definition of EHRI.
One of the most significant changes in the final rule is the removal of the proposed requirement that a sponsor holding an EHRI be subject to certain cash flow restrictions. The reproposal included a restriction on projected cash flows to be paid to an EHRI that would have limited how quickly the sponsor would have been able to recover the fair value amount of the EHRI in the form of cash payments from the securitization (or, if an eligible horizontal cash reserve account were established, released to the sponsor or other holder of such account). The sponsor would have been prohibited from structuring a deal where it was projected to receive such amounts at a faster rate than the rate at which principal was projected to be paid to investors on all ABS in the securitization. Many commenters sought to remove the proposed restriction on cash flow distributions as it would be incompatible with a variety of securitization structures. The agencies agreed that the cash flow restriction would have unintended consequences and therefore did not include such provision in the final rule.20
1 As in the final rule, this regulatory briefing uses the term "agencies" to refer to the appropriate agencies with rulewriting authority with respect to a particular asset class, securitization or matter discussed.
2 The complete text of the final rule as adopted by the agencies, along with the agencies' adopting commentary (the "adopting release"), is available at http://www.sfindustry.org/images/uploads/pdfs/Risk_Retention_Final_Rule.pdf. Page references to the adopting release in this regulatory briefing refer to the copy of the adopting release available at the preceding website address.
3 Pub. L. No. 111-203, 124 Stat. 1376 (2010) [hereinafter the "Dodd-Frank Act"].
4 Section 15G defines a "securitizer" as either: "(A) an issuer of an asset-backed security; or (B) a person who organizes and initiates an asset-backed securities transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuer." Section 15G(a)(3) of the Exchange Act.
5 Section 15G(c)(1)(A) of the Exchange Act.
6 Section 15G(b)(1) of the Exchange Act.
7 76 Fed. Reg. 24,090 (Apr. 29, 2011) available at http://www.sfindustry.org/images/uploads/pdfs/Risk%20Retention%20Proposal.pdf .
8 78 Fed. Reg. 57,931 (Sept. 20, 2013) available at http://www.sfindustry.org/images/uploads/pdfs/Credit%20Risk%20Retention%20Proposed%20Rule.pdf .
9 The Structured Finance Industry Group's ("SFIG") Comment Letter on the reproposal can be found at http://www.sfindustry.org/images/uploads/pdfs/Credit%20Risk%20Retention.pdf [hereinafter the "SFIG 2013 Comment Letter"].
10 See Section 15G(i)(1)–(2) of the Exchange Act.
11 § __.4(a) of the final rule.
12 § __.4(b) of the final rule.
13 Many members of SFIG, particularly sponsors, advocated for a simplified version of the representative sample method similar to the FDIC's safe harbor be included in the final rule. See SFIG 2013 Comment Letter, supra note 9, at 28–30.
14 See 12 CFR § 360.6, as amended [hereinafter the "FDIC safe harbor"].
15 The adopting release's reference to rejecting overcollateralization as a form of risk retention may be potentially confusing. While the agencies appear to have rejected overcollateralization as a risk retention option when such overcollateralization is based on a comparison of the face value of the securitized assets to the face value of ABS interests, the adopting release recognizes that the fair value of an EHRI takes into consideration the overcollateralization and excess spread in a securitization transaction as adjusted by expected loss and other factors. Therefore, overcollateralization, as a component of an EHRI, is still a permitted form of risk retention. See adopting release, supra note 2, at 48.
16 See id. at 27.
19 See clause (2) of the definition of "Eligible horizontal residual interest" in § __.2 of the final rule.
20 Adopting release, supra note 2, at 25.
Originally published 5 November 2014
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