Originally published August 5, 2009
Keywords: securitization, financial regulatory reform, credit risk, securitizers, asset-backed securities, credit ratings
On July 22, 2009, the Obama administration delivered proposed legislation to Congress that addresses several of the administration's key policy objectives for the securitization markets. The proposed legislation is part of the follow-up on the administration's June 17 report entitled "Financial Regulatory Reform: A New Foundation" (the "Report"). We summarize the proposed legislation below.
Requiring Originators or Sponsors to Retain Credit Risk
As contemplated by the Report, the proposed legislation would require the federal banking agencies and the SEC jointly to prescribe regulations that require "securitizers" (defined as issuers and, surprisingly, underwriters) to retain at least 5 percent of the credit risk of securitized assets. The legislation sets a 180-day deadline (post enactment) for the regulations to be prescribed and requires that the regulations:
- Ban hedging or otherwise transferring the minimum retention;
- Specify the permissible forms of risk retention (e.g., first loss position vs. a pro rata "vertical slice") and the minimum duration;
- Apply regardless of whether or not the securitizer is a bank or other insured depository institution;
- Provide exemptions (i) for assets issued or guaranteed by the United States, its agencies and its government-sponsored enterprises and (ii) otherwise as appropriate in the public interest (e.g., for bank safety and soundness) or for investor protection; and
- Provide for the allocation of risk-retention obligations between "originators" (defined as a person who sells an asset to a securitizer) and securitizers.
Periodic Reporting on Asset-Backed Securities (ABS)
In the Report, the administration called for legislative action to give the SEC clear authority to require robust ongoing reporting by ABS issuers. The proposed legislation would follow up on that aspect of the Report by:
- Modifying Section 15(d) of the Securities Exchange Act to exclude ABS issuers from the provisions that allow issuers to discontinue periodic reporting if the related securities are held of record by fewer than 300 persons; and
- Requiring the SEC to adopt expanded disclosure regulations for ABS issuers, including loan-level data and disclosure on the nature and extent of broker and originator compensation and risk retention by the originator or securitizer.
Representations and Warranties in ABS Offerings
The proposed legislation would also require the SEC to prescribe regulations that:
- Require credit rating agencies to address representations, warranties and related enforcement mechanisms in rating reports on ABS; and
- Require disclosure on fulfilled repurchase requests across all trusts aggregated by originator.
Eliminating Section 4(5) of the Securities Act
Finally, the legislation would delete Section 4(5) of the Securities Act, which currently exempts from the registration requirements of that Act certain sales of residential mortgage loans and participation interests therein. The Report did not include any obvious mention of this change, and it is not clear what motivated the administration to propose it. The eliminated section is most relevant to secondary market sales of whole mortgage loans, which generally also qualify as private placements and can avoid registration on that basis.
Other Changes Proposed in the Report
A separate legislative package delivered by the administration proposes additional regulation of credit rating agencies, consistent with the Report. At this point, it does not appear that other securitization-related proposals included in the Report will be addressed by legislation. These include proposals to
- Reduce reliance on credit ratings in SEC rules and exercise caution in relying on them in risked-based capital regulations;
- Minimize opportunities for regulatory arbitrage (where firms use securitization to reduce their regulatory capital requirements without a commensurate reduction in risk);
- Eliminate gain on sale for many securitizations and require consolidation of more securitized assets on the originator's balance sheet; and
- Adjust incentives for ABS market participants through performance-based, medium- to long-term approaches to compensation (except to the extent addressed by the Corporate and Financial Institution Compensation Fairness Act of 2009 (H.R. 3269), which the House of Representatives passed on Friday, July 31).
We believe that most of these remaining proposals are meant to be addressed by existing, completed or future rulemaking or similar actions, some of which were identified in our July 6, 2009, summary of the securitization aspects of the Report, "Financial Regulation Reform and Securitization," available at http://www.mayerbrown.com/publications/article.asp?id=7191&nid=6.
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